Is Canadian Oil Sands Ltd. and its Gigantic 8.2% Dividend Yield Safe?

Lately, as the price of oil has plummeted, Canadian Oil Sands Ltd. (TSX: COS) has piqued the interest of many value investors. The stock is trading at levels it last saw in 2009, back when oil was trading at a measly $40-$50 per barrel. Considering how oil is between $75 and $80 for the moment, it certainly seems like the stock is undervalued. But, alas, it’s no longer 2009. Costs have crept up over the years. As the easy oil gets extracted, subsequent reserves become a little more expensive and harder to mine. And the company continues to be forced to make…

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Lately, as the price of oil has plummeted, Canadian Oil Sands Ltd.(TSX: COS) has piqued the interest of many value investors. The stock is trading at levels it last saw in 2009, back when oil was trading at a measly $40-$50 per barrel. Considering how oil is between $75 and $80 for the moment, it certainly seems like the stock is undervalued.

But, alas, it’s no longer 2009. Costs have crept up over the years. As the easy oil gets extracted, subsequent reserves become a little more expensive and harder to mine. And the company continues to be forced to make costly repairs on its upgrading system, which turns oil sands sludge into light crude, enabling the company to sell its crude at a pretty significant premium to what oil sands operations can command.

The market is also sending investors a huge warning about the dividend. A general rule of thumb is that any dividend over 8% is at risk to getting cut. Is that the case with Canadian Oil Sands? Let’s take a closer look.

The saving grace

Even though the price of both Brent and West Texas Intermediate crude oil is down approximately 15% over the last 30 days — and 30% of summer peaks — doesn’t mean Canadian producers are in such bad shape. There are a couple of reasons for this.

Oil is priced in U.S. dollars. As the Canadian dollar declines against the U.S. greenback, that helps minimize the damage caused by falling oil prices. A year ago, the two currencies were pretty much at par. These days, the Loonie trades at 87 cents U.S., giving Canadian producers a 13% boost compared to just a year ago.

The other thing helping producers is the support of Canadian crude prices compared to the rest of the world. Various oil sands producers have been forced to cut production, and many new oil sands projects of any scale aren’t ready to come online yet. Combine that with transportation bottlenecks and more U.S. refiners willing to accept Canadian heavy crude, and that translates into better prices for Canadian producers across the board.

In fact, once you control for all these factors, companies selling light crude like Canadian Oil Sands are getting the equivalent of almost $90 per barrel of oil. That’s not ideal, but it certainly isn’t as bad as it looks on paper.

How about the dividend?

If oil prices and current exchange rates stay steady, Canadian Oil Sands won’t have any problem maintaining the dividend.

According to a recent investor presentation, the company predicts a cash flow from operations of approximately $1.75/share in 2015 based on $75 per barrel oil and an exchange rate of $1.04. As previously mentioned, today’s exchange rate is $1.13, so we can add an additional 9% to those numbers, which puts projected cash flow somewhere between $1.90-$1.95 per share. The current dividend is $1.40 per share. This leaves plenty of room to spare.

Additionally, the company is set to not have any major capital expenditures for the first time in years. So even though cash flow from operations is a number which already includes capital expenses, this still gives an investor some room for error. Think of it as a margin of safety.

There’s no doubt that Canadian Oil Sands’ dividend is one of the riskier ones in the patch. It pays nearly all of its earnings out to investors, keeping just enough to keep things running smoothly and pay down its debt. But barring another leg down for crude prices, the company’s dividend looks to be safe. I think investors will do just fine to buy now and wait a few years for oil prices to recover.

Or, if you’re looking for a different type of energy stock, read on. We’ve got a couple that could be huge winners.

Fool contributor Nelson Smith has no position in any stocks mentioned.

I consent to receiving information from The Motley Fool via email, direct mail, and occasional special offer phone calls. I understand I can unsubscribe from these updates at any time. Please read the Privacy Statement and Terms of Service for more information.